Demand for the latest smattering of REIT (Real Estate Investment Trust) issues was deemed particularly strong last week, although market professionals do not expect the deal-flow to increase accordingly. At time of writing, factory outlet center Tanger Properties Ltd., was planning to price a $75 million seven-year bullet transaction via Merill Lynch. LNR Property Corp., had priced a sizeable increase of its outstanding 10.50% senior subordinated notes.
Proceeds of the Tanger deal will be used to repay $75 million of 8.75% senior unsecured notes due March 2001, the intention being to lengthen the borrower's debt maturity schedule and improve its financial flexibility. Demand skyrocketed as holders of the original bonds showed willing to participate in a new deal. Demand was even stronger for LNR's opportunistic add-on via Deutsche Banc Alex. Brown. What was originally billed as a $50 million deal had burgeoned to $135 million by the time it was priced.
Led by DBAB, LNR's opportunistic add-on will be used to repay bank debt and for general corporate purposes. Before the prospect of an upsizing emerged, the original bonds were trading just under par.
The time is right
REITs are popular among investors for the tax considerations and high yield they offer. They are also seen as a liquid method of investing in real estate. The sector has more than quadrupled in size in the last three years, but the focus remains on the equity rather than the bond aspect. Prospective bond issuers look for certain conditions before bringing deals to market.
The credit quality of the average REIT is stable and the sector has demonstrated its ability to operate in a tough capital environment and maintain a good credit profile. With interest rates coming down and investors looking for a safe haven with companies that have real assets, the time is right for REITs. And management teams have been generally disciplined in terms of where they've invested - selling out of weaker markets and re-deploying in stronger and better ones - which puts them in a good position to potentially ride through a tougher economy.
REITs are of particular interest to life insurance companies and buyers of commercial mortgage-backed securities that know property types and can easily get the risk underwritten. "This group of investors was active in the real estate market long before the REIT debt market really came into being in the early 90s," said Scott O'Shea, senior director at Fitch Rating Agency's REITs group. "There is a roughly $50 billion unsecured debt market today, mostly issued since early 1990 when it became a newer part of the corporate bond market."
The sector last saw supply in January when MeriStar Hospitality successfully placed a two-tranche offering of 2008 and 2011 notes totaling $500 million, and Felcor Lodging issued $100 million of 9.5% notes due 2008. Both deals were well received. The unsecured REIT market generally offers 40% to 50% on a loan-to-value (LTV) basis - a more conservative level of leverage than the 50% to 70% that is more typical of the secured market. O'Shea believes that this provides ample risk reward to attract life insurance companies.
A soft landing?
But although REITs have earned a reputation for resilience in times of trouble, analysts believe it is still too early to predict what would happen in the event of a major downturn in the market. There is no guarantee that, in the wake of a recession, REITs will have a soft landing. "It's not going to be a replay of the 90s where there was a huge imbalance of supply and demand when REITs were overbuilding," said Philip Kibel, senior analyst at Moody's Investors Service. "But it could be somewhat rough."
And some real estate investors agree. Despite having the security of hard assets in the event of a restructuring, some portfolio managers prefer to steer clear of the sector. The retail REITs sector is particularly unappealing to those thinking of dipping a toe in the market. Fewer retailers, coupled with reduced consumer demand as a result of a slowing economy instills fears of a rollback to the outlet market. "Like every other retail concept there is over-proliferation in factory outlets," said one portfolio manager.
Kibel noted too that the gap between the "haves" and "have-nots" is widening. Tenants are increasingly demanding that commercial spaces be equipped with the latest technology, like high speed Internet access. The REITs that will succeed will be those that can quickly accommodate those demands. This is in addition to proving that they can translate growth in real estate portfolios into better market share positions by divesting weaker properties and investing in stronger ones.
Last week, Moody's downgraded Michigan-based Omega Healthcare Investors Inc. to Caa1 from B3 because of continuing pressure stemming from the troubled long-term care facilities operators and mortgagors that make up roughly 90% of the REIT's assets. The possibility of a corporate restructuring that could hinder the positions of bondholders and preferred stock investors was also reflected in the downgrade.
Moody's rated the proposed Tanger issue Ba2, reflecting the company's moderately high financial leverage given its relatively small size and the fact that its primary focus is on the retail outlet center business. "Tanger's focus on the retail outlet segment continues to be a credit concern because retail is very sensitive to economic conditions, and consumer spending on clothes and trends," Kibel said.